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On Thursday, January 28, William Nordhaus joined Markus’ Academy for a lecture on climate compacts to combat free riding in international climate agreements. Nordhaus is a Professor of Economics at Yale University and a 2018 recipient of the Nobel Prize in Economics.

Watch the full presentation below and download the slides here. You can also watch all Markus’ Academy webinars on the Markus’ Academy YouTube channel.

Executive Summary

  • There has been little progress in slowing emissions. Global CO2 emissions through 2019 has been growing at 2.5% a year while decarbonization — the CO2 per unit output — has been declining at about 1.5% a year. Notably, the Paris agreement is not ambitious enough to reach the target decarbonization of 2 degC.
  • Climate innovation is plagued by a double externality. Like for all innovations, social returns are greater than private returns leading to too little R&D. Second, climate impacts are underpriced. Only the latter can be alleviated with carbon pricing. 
  • Currently, the federal budget for military versus green energy R&D is 60 billion vs 2 billion dollars. Thus, the incentives at the federal level are structured to produce advanced nuclear weapons and not renewable and low-carbon energy. Notably, the first is a zero sum game while the latter is a collaborative development.
  • A high price on CO2 emissions is a key to sharp emissions reductions. This will provide incentives for companies to move away from old technologies and to develop new technologies to remove their CO2 emissions. Currently, the carbon prices are muddled across industries/location, fragmented, and low. Looking forward,  the level of the price should be harmonized across industries, countries, and time to meet the climate target. 
  • The carbon price landscape in 2019 varied across regions and sectors. 80% of regions had a zero carbon price and the average effective price was $1.7 / ton, which is incredibly low. Even more striking is the fact that global carbon prices are dwarfed by fossil subsidies, which were very vast at around $10/ton, meaning net prices are negative. In addition there are feed-in tariffs and regulation. We do not have measures for the latter two categories and more research needs to be devoted to that.
  • International climate policy is at a dead end because of the global free rider problem, where the costs and benefits are very disperse. No country gets more than 15% of the impacts and benefits of their policies, so the majority of benefits are spillover which provides little incentives. There is evidence of this from low carbon prices, little decrease in CO2 emissions, and collapse of the Kyoto protocol in 2012, when countries peeled off together because there was no penalty for not joining or withdrawing. The current problem is that these agreements are voluntary and there are no costly penalties for non-participation. 
  • An effective international agreement requires incentives, such as a climate compact or club. This would include requirements for members of the club and a penalty on non-participants. For example, an agreement could establish a target carbon price with a penalty tariff on non-participants. Modelling run at Yale has shown that no tariff penalties lead to no participation while increases in tariffs increases the number of participants, with a tipping point at around a 2% tariff. 
  • In summary, there has been little progress in slowing warming, low-carbon technologies are plagued by double externalities, there should be a central goal of high and harmonized carbon prices, and effective international policies require climate compact structure with carrot and sticks.